The 28 Facts Franchisees Need to Know About Real Estate Leases
If you've never had to negotiate a lease for a business, this primer will help you understand the basics about franchise location leases.
The following excerpt is from Rick Grossman's book Franchise Bible. Buy it now from Amazon | Barnes & Noble | iTunes | IndieBound
Once a franchisee has completed the site selection process, they'll be ready to work with the landlord to secure an acceptable commercial lease. Like so many other contracts, there are no "form" or "standard" leases, and a landlord can fashion any contract they want.
At the end of the day, it's the franchisee who'll be responsible for understanding the lease and who'll be called upon to perform under its terms, so you have to read it! To help with that process, here are the major points to consider in reviewing a commercial lease.
1. Base Provisions
This first section of most leases contains the general overview of the terms and conditions of the lease. It will identify by name and by contact information both the landlord and tenant and also includes the following:
- The identification of the Premises to be leased including the location in the center, the square footage and any other identifying information.
- The Term of the lease. This may be expressed as a number of months (for example, 60 months), a number of years (for example, five years) or a mixture of both.
- A statement of the base rent, the CAM (Common Area Maintenance) costs, and a statement of the tenant's pro rata share of CAM costs, landlord's insurance, real estate taxes and the like.
- A statement of the tenant's security deposit. The security deposit is used to insure the full and faithful performance of the tenant under the lease.
- A statement of the permitted use. The permitted use is literally the use for which the tenant is renting the property -- be it a pizza restaurant or a children's clothing store.
- The identification of the common areas (being those areas that are used in common for the benefit of all tenants, including walkways, parking lots, stairwells and the like) for which the CAM cost is calculated.
2. The Grant
This section will state that the tenant is being granted the right to use the Premises.
3. The Term
This section will expand upon the Base Provisions by identifying the date of delivery of the Premises to the tenant by calling out reasons for a delay in the delivery of the Premises to the tenant, and similar matter.
4. Condition of the Premises
This section will go over the condition of the Premises at the time that it's delivered to the tenant and discuss what the tenant must do in terms of work in order to bring the Premises to a fully rentable condition.
5. Landlord and Tenant Work
In most cases, the lease will provide that the landlord will deliver the Premises to the tenant with basic work already completed. The lease will then call out the work that the tenant has to complete in order to open its doors.
6. Opening Date
Most leases will require that the tenant be open no later than the stated date.
7. Rent, Additional Rent, Percentage Rent
Most commercial leases will have several components that make up the total Rent. Such fees include the tenant's payment of their pro rata share of the CAM costs, the tenant's pro rata share of the real estate taxes assessed against the entire project, and the tenant's pro rata share landlord's insurance premiums paid in exchange for insurance on the entire project.
8. Past Due Rent
The lease will spell out the consequences of missing a Rent payment. This can range from a mere penalty of a percentage of the missed payment (that is, 5 percent of the amount that was due) or a fixed dollar figure, to a combination of both along with other consequences.
9. Security Deposit
All leases will have an article that addresses the use of the Security Deposit. In most cases, the covenant will require the tenant to maintain the amount of the deposit in case the landlord uses any portion of it to cure a tenant breach.
10. Tenant's Obligations
The landlord may include a list of the tenant's general obligations concerning smoking, trash removal, compliance with laws and the like.
11. Maintenance and Repairs
The landlord will spell out in detail the tenant's Maintenance and Repair obligations. Typically, the tenant is responsible for maintaining and repairing when necessary each and every system located within the Premises including the plumbing, electrical, HVAC, walls, ceilings and floors, lighting and the like.
12. Common Area
This coverage will identify the components of the Common Area (including walkways, roof covering, the parking lot, public area lighting and the like) and will state that all costs incurred for the maintenance, repair and replacement of such items will be included in the CAM cost.
This section will identify the utilities that are payable directly by the tenant and those that will be payable by the landlord.
The landlord passes the real estate tax burden for the entire project on to all of the tenants through a pro rata charge, which is identified as Additional Rent. This is usual.
The landlord will also pass on to the tenants, pro rata, the cost of all insurance premiums spent to insure the entire project. The tenant will also be required to purchase specific insurance policies to insure its operation of the franchised business and to insure against any hazard or other loss.
16. Furniture, Fixtures and Equipment (FF&E)
The lease will call out the requirements for the tenant's FF&E, will account for the use of exterior and interior signs, and will identify what items are trade fixtures (those owned by the tenant) and what are real estate fixtures (those items that when attached by the tenant to the Premises become the landlord's property).
17. Hazardous Materials
The lease will be specific in limiting the tenant's right to use, store or generate hazardous materials or substances.
18. Damage by Fire, Hazard or Other Loss
This section will go over the rights and obligations of the parties in the case of loss by fire hazard or other occurrence.
19. Eminent Domain
Eminent Domain is the right granted to the state or federal government (and to certain private individuals) to take another person's property for just compensation. Often called a condemnation, an Eminent Domain action requires the landlord and tenant to determine how their leasehold interests will be affected.
20. Exclusive Use
It's always worth negotiating for a covenant that gives the franchisee/tenant the right to be the sole and only business in the project that offers the franchisee's goods or services. This will give you the comfort of knowing that no direct competitor will be allowed into the space.
21. Assignment and Subletting
This section will outline how the landlord will control the tenant's right to assign the lease to a new tenant and how they'll also have the right to limit the tenant's right to sublease the space.
22. Default of Tenant Under the Lease
This section will cover the landlord's position on breaches of the lease.
The Damages covenants may be part of the Default covenant or may be a standalone article. Upon breach of the lease the landlord will have the right to: (i) terminate the lease and seek damages for past events; (ii) terminate the lease and seek not only past damages, but damages for the loss of future rents (less any rent paid by a new tenant); (iii) seek to evict the tenant from possession but not terminate the lease, and to then seek past and future damages; or (iv) seek any combination of the above as well as any other damages allowed by law.
This is a legal term that means the tenant's right to possession under the lease are junior to (thus "subordinate") to the superior rights of any lender to the landlord who has taken a security interest in the entire project. This means that the lender can take possession of the project, subject to the tenant's rights under the lease, should the landlord fail to pay on its loan.
25. Holding Over
This outlines the terms of the tenant's continued possession of the Premises after the lease has expired or has been terminated.
26. Covenant of Quiet Enjoyment
This is one of the most important covenants for the tenant. Basically, it provides that the tenant will be able to "enjoy" the use of the Premises without interference from the landlord or other tenants for so long as the tenant abides by the terms of the lease. It's this covenant that an injured tenant will point to if there is a violation of the lease by the landlord.
27. Landlord's Interest
Leases usually have a special covenant that states that the project itself is the only interest against which the tenant can collect any damages suffered. Given that landlords usually mortgage a commercial property to the greatest extent possible, in practice, this covenant usually means there's not a ready pile of cash available to pay a tenant for losses.
28. Additional Provisions
The Additional Provisions article will cover such matters as the merger of prior agreements, oral or written, into the current written lease, the manner by which written notice is to be delivered to a party, or the fact that there are rules and regulations that must be followed.
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